

[Federal Register: October 19, 2007 (Volume 72, Number 202)]
[Notices]               
[Page 59317-59321]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr19oc07-92]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56645; File No. SR-NASD-2005-080]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc. (n/k/a Financial Industry Regulatory Authority, Inc.); 
Notice of Filing of Amendment No. 4 and Order Granting Accelerated 
Approval of Proposed Rule Change as Modified by Amendment Nos. 1, 2, 3 
and 4 Relating to Fairness Opinions

October 11, 2007

I. Introduction

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ on 
June 22, 2005, the National Association of Securities Dealers, Inc. (n/
k/a Financial Industry Regulatory Authority, Inc. (``FINRA'')), filed 
with the Securities and Exchange Commission (``Commission'') a proposed 
rule change relating to fairness opinion disclosures and procedures.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    On April 4, 2006, the Commission issued a release noticing the 
proposed rule change, as modified by Amendment Nos. 1, 2, and 3, which 
was published for comment in the Federal Register on

[[Page 59318]]

April 11, 2006.\3\ The comment period expired on May 2, 2006. The 
Commission received eight comment letters in response to the proposed 
rule change.\4\ On June 7, 2007, FINRA filed Amendment No. 4 to the 
proposed rule change. This order provides notice of the proposed rule 
change, as modified by Amendment No. 4, and approves the proposed rule 
change as amended on an accelerated basis.
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    \3\ See Securities Exchange Act Release No. 53598 (April 4, 
2006), 71 FR 18395 (April 11, 2006) (``Original Proposal'').
    \4\ See Letters to Jonathan G. Katz, Secretary, Commission, 
from: Michael W. Kane, Ph.D., J.D., President and CEO, Kane & 
Company, Inc. (May 1, 2006); Donna M. Hitscherich, Faculty, Columbia 
University Graduate School of Business, New York (May 1, 2006); 
Gilbert E. Matthews, CFA, Chairman, Sutter Securities Incorporated 
(May 1, 2006); Ann Yerger, Executive Director, Council of 
Institutional Investors (May 1, 2006); John Faulkner, Chair, Capital 
Markets Committee, Securities Industry Association (May 2, 2006); 
Marjorie Bowen, Managing Director, National Co-Director of Fairness 
Opinion Practice, Houlihan Lokey Howard & Zukin Capital, Inc. (May 
2, 2006); Daniel S. Sternberg, Committee Chair, Special Committee on 
Mergers, Acquisitions and Corporate Control Contests, The 
Association of the Bar of the City of New York (May 3, 2006); 
Michael J. Holiday, Chair, Committee on Securities Regulation, New 
York State Bar Association (May 11, 2006).
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II. Background

    FINRA is proposing to establish new Rule 2290 to address 
disclosures and procedures in connection with the issuance of fairness 
opinions by member firms. Fairness opinions are routinely obtained by 
boards of directors in corporate control transactions and address the 
fairness, from a financial perspective, of the consideration being 
offered in the transaction.
    Fairness opinions may serve a variety of purposes, including as 
indicia of the exercise of care by the board of directors in a 
corporate control transaction as well as to supplement information 
available to shareholders and, as such, are often provided as part of 
proxy materials. Fairness opinions offer a view as to whether the 
consideration offered in a deal is within the range of what would be 
considered ``fair,'' rather than offering an opinion as to whether the 
consideration offered is the best price that could likely be attained.
    In its proposal, FINRA expressed concern that the disclosures 
provided in fairness opinions may not be adequate to alert shareholders 
as to potential conflicts of interest that may exist between the firm 
issuing the opinion and the parties involved in the transaction. For 
example, in many cases, the firm issuing the fairness opinion is also 
acting as an advisor to a party to the transaction. As such, there may 
be a contingent compensation structure dependent upon the success of 
the deal. There may also be other material relationships between the 
member firm and a party to the transaction that is the subject of the 
fairness opinion involving compensation that has been, or is intended 
to be, received. Thus, the proposed rule change would provide 
shareholders with certain disclosures with regard to any fairness 
opinion issued by a member firm if, at the time of its issuance to the 
board of directors, the member knows or has reason to know that the 
fairness opinion will be provided or described to the company's public 
shareholders.
    Further, the proposed rule change seeks to require member firms to 
establish written procedures for use in issuing fairness opinions, 
including addressing when a member firm will employ the use of an 
internal committee in approving a fairness opinion. In cases where a 
committee is used, the member must set forth in its procedures, among 
other things, the process for selecting personnel to be on the fairness 
committee.

III. Discussion

    The Commission received eight comment letters in response to the 
proposed rule change.\5\ As discussed below, commenters generally 
supported the fundamental goals and objectives behind the proposed rule 
change, and several commenters suggested modifications or requested 
clarification. In response to various concerns and suggestions raised 
by commenters, FINRA filed Amendment No. 4 to the proposed rule change.
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    \5\ See supra note 4.
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    After careful review, the Commission finds, as discussed more fully 
below, that the proposed rule change is consistent with the 
requirements of the Exchange Act and the regulations thereunder 
applicable to FINRA.\6\ In particular, the Commission believes that the 
proposed rule change is consistent with Sections 15A(b)(6) and 
15A(b)(9) of the Exchange Act.\7\
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    \6\ See 15 U.S.C. 19(b)(2).
    \7\ 15 U.S.C. 78o-3(b)(6) and (9).
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    Section 15A(b)(6) requires that the rules of a registered national 
securities association be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest. Section 15A(b)(9) requires 
that the rules of an association not impose any burden on competition 
that is not necessary or appropriate in furtherance of the purposes of 
the Exchange Act.
    Section 3(f) of the Exchange Act directs the Commission to 
consider, in addition to the protection of investors, whether approval 
of a rule change will promote efficiency, competition, and capital 
formation.\8\ In approving the proposed rule change, the Commission has 
considered its impact on efficiency, competition, and capital 
formation.
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    \8\ 15 U.S.C. 78c(f).
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    The Commission believes that the proposed rule change provides 
investors with useful information in understanding the primary 
potential conflicts of interest faced by member firms that issue 
fairness opinions. The proposed rule change is tailored to require any 
member firm that issues a fairness opinion to include the specified 
disclosures only where the member firm knows or has reason to know that 
the fairness opinion will be provided or described to the company's 
public shareholders. Thus, even though an opinion may be prepared for 
use by the board of directors of a client of a member firm, because the 
fairness opinion is usually included in materials provided to public 
shareholders, these shareholders will now be made aware of potential 
conflicts of interest with regard to the existence of contingent 
compensation arrangements and other material relationships between the 
member and any party to the transaction that is the subject of the 
fairness opinion.
    Further, new Rule 2290's procedural requirements provide safeguards 
to help member firms manage potential conflicts of interest in 
approving fairness opinions by, among other things, requiring that any 
fairness committee formed must include representation by persons who do 
not serve on the deal team to the transaction that is the subject of 
the fairness opinion.

A. Disclosure Regarding Compensation Contingent Upon the Successful 
Completion of a Transaction

    New Rule 2290(a)(1) requires that when a member firm acts as a 
financial advisor to any party to a transaction that is the subject of 
a fairness opinion issued by the firm, the member must disclose if the 
member will receive compensation that is contingent upon the successful 
completion of the transaction, for rendering the fairness

[[Page 59319]]

opinion and/or serving as an advisor. New Rule 2290(a)(2) also requires 
that a member firm disclose if it will receive any other significant 
payment or compensation that is contingent upon the successful 
completion of the transaction.
    Commenters were generally supportive of these provisions. However, 
one commenter suggested that the disclosure should be quantitative, 
disclosing the actual amount of the contingent compensation that would 
be received by the member firm, rather than descriptive, disclosing 
only the existence of such compensation arrangement. Commenters also 
expressed concern regarding tracking smaller amounts of contingent 
compensation or other payments and suggested a threshold amount in 
order to make compliance more practicable. Two commenters also 
requested that FINRA clarify that the existence of such contingent 
compensation arrangement does not constitute an acknowledgement that an 
actual conflict of interests exists.
    In FINRA's response to comments, FINRA stated that it continues to 
believe that it is sufficient that shareholders are aware of the 
existence of a contingent compensation relationship. FINRA also did not 
determine it appropriate to clarify in the rule text that the existence 
of a contingent compensation arrangement is not an acknowledgement that 
an actual conflict of interests exists. However, in Amendment No. 4, 
FINRA explained, among other things, that the proposed rule change does 
not presume a conflict merely because the disclosures are made. 
Further, in Amendment No. 4, FINRA amended the ``catch-all'' provision 
of paragraph (a)(2) regarding other payments or compensation by adding 
a ``significant'' qualifier. FINRA noted that it believes this change 
will ease compliance burdens.
    We believe that a descriptive disclosure that alerts shareholders 
to the existence of a contingent compensation arrangement is sufficient 
to serve the basic purpose of highlighting for investors that the 
issuing member stands to benefit financially from the successful 
completion of the transaction, and therefore, that a conflict of 
interests may exist. We also believe that adding the ``significant'' 
qualifier strikes a proper balance. The Commission finds that the 
proposed rule change requiring disclosure of contingent compensation 
for rendering the fairness opinion and/or serving as an advisor, or of 
other significant payments dependent on the successful outcome of the 
transaction, are consistent with the Exchange Act, particularly 
Sections 15A(b)(6) and 15A(b)(9).

B. Disclosure of Material Relationships Between the Member and Parties 
to the Transaction

    New Rule 2290(a)(3) requires that member firms disclose any 
material relationships that existed during the past two years or 
material relationships that are mutually understood to be contemplated 
in which any compensation was received or is intended to be received as 
a result of the relationship between the member and any party to the 
transaction that is the subject of the fairness opinion.
    Several commenters expressed concern that the requirement was 
overbroad and implied that members must breach confidential obligations 
or make premature disclosures of non-public information. FINRA noted 
that the disclosure provision of paragraph (a)(3) is largely based on 
Item 1015(b)(4) of the Commission's Regulation M-A and was less 
specific than Item 1015(b)(4) because the disclosures of ``material 
relationships'' in the proposed rule change are descriptive rather than 
quantitative.
    In Amendment No. 4, FINRA made one modification to this provision 
to clarify that each of the material relationships should be identified 
in the fairness opinion. The Commission finds that the disclosure 
requirement regarding material relationships is consistent with the 
Exchange Act, particularly Sections 15A(b)(6) and 15A(b)(9).

C. Disclosure Regarding Independent Verification of Information That 
Formed a Substantial Basis for the Fairness Opinion

    New Rule 2290(a)(4) requires that members disclose if any 
information that formed a substantial basis for the fairness opinion 
that was supplied to the member by the company requesting the opinion 
concerning the companies that are parties to the transaction has been 
independently verified by the member, and if so, a description of the 
information or categories of information that were verified.
    Paragraph (a)(4) in the Original Proposal would have required 
disclosure of the categories of information that formed a substantial 
basis for the fairness opinion that was supplied to the member by the 
company requesting the opinion concerning the companies involved in the 
transaction, and whether any such information has been independently 
verified by the member. Two commenters believed that this requirement 
should be deleted because it was not clear what ``verify'' the 
information meant. One commenter asserted that in most cases this 
information could not be verified so the disclosure of the categories 
of information would be meaningless for the investor. FINRA clarified 
in Amendment No. 4 that it did not intend to require independent 
verification of the information provided to the member. Rather, as 
noted by FINRA in Amendment No. 4, the disclosure is intended to 
provide a public shareholder with information concerning the extent to 
which information relied on by the member was verified. Upon further 
review, FINRA determined that disclosing the categories of information 
that formed a substantial basis for the fairness opinion would not 
provide meaningful guidance to the investor, particularly when this 
information is not ``verified.''
    Accordingly, in Amendment No. 4, FINRA retained the provision 
requiring disclosure if any information that formed a substantial basis 
for the fairness opinion that was supplied by the company requesting 
the opinion has been verified and, if so, the requirement that the 
member disclose a description of the verified information or categories 
of this information. FINRA eliminated, however, the requirement to list 
each category of information when such information has not been 
verified. FINRA noted that when no information has been verified, a 
blanket statement to that effect, as is common practice today, would be 
sufficient. The Commission finds that the disclosure requirement 
regarding verification of information supplied by the company 
requesting the opinion that formed a substantial basis for the opinion 
is consistent with the Exchange Act, particularly Sections 15A(b)(6) 
and 15A(b)(9).

D. Disclosures Regarding Use of a Fairness Committee

    New Rule 2290(a)(5) requires member disclosure of whether or not 
the fairness opinion was approved or issued by a fairness committee. 
Commenters supported the use of committees and noted that use of such 
committees is commonplace today. One commenter believed that the 
disclosure was not material and may create a misleading impression that 
a fairness opinion rendered by a fairness committee is substantively 
better than one not approved by a committee. The commenter suggested, 
however, that if the provision is retained, FINRA should revise the 
rule text to acknowledge that a fairness committee may not always be

[[Page 59320]]

called a ``fairness committee'' within a particular firm.
    In Amendment No. 4, FINRA stated its belief that fairness opinions 
that are approved by a fairness committee that follows the procedures 
required by the proposed rule generally are less susceptible to 
conflicts and that fairness opinions should include disclosure 
regarding whether a fairness committee was used. Regarding the term 
``fairness committee,'' FINRA also believes that the term would include 
any committee or group that approves a fairness opinion in accordance 
with the procedural requirements of paragraph (b) regardless of whether 
the member calls it a ``fairness committee.'' In addition, FINRA 
amended the rule language to clarify that members must specifically 
disclose whether or not a fairness committee approved or issued the 
fairness opinion. The Commission finds that the disclosure requirements 
regarding use of a fairness committee are consistent with the Exchange 
Act, particularly Sections 15A(b)(6) and 15A(b)(9).

E. Disclosure Regarding Relative Compensation to Officers, Directors, 
and Employees

    New Rule 2290(a)(6) requires member firms to disclose whether or 
not the fairness opinion expresses an opinion about the fairness of the 
amount or nature of the compensation from the transaction underlying 
the fairness opinion, to the company's officers, directors or 
employees, or class of such persons, relative to the compensation to 
the public shareholders of the company.
    The Original Proposal would have required members to establish a 
process by which the member would evaluate the degree to which the 
amount and nature of the compensation from the transactions underlying 
the fairness opinion benefits insiders relative to the benefits to 
shareholders. Commenters argued that members do not possess the 
expertise to make this determination and that this type of 
determination is outside of the scope of what the member opines on in a 
fairness opinion. In Amendment No. 4, FINRA revised the proposed rule 
in response to comments, stating that it believes the disclosure in new 
Rule 2290(a)(6) suitably highlights to the investor the potential 
conflict of interests between the member issuing the fairness opinion 
and the party receiving the opinion by requiring disclosure whether the 
member did or did not take into account the amount and nature of 
compensation flowing to certain insiders relative to the benefits to 
shareholders in reaching a fairness determination.
    The Commission finds that this provision is consistent with the 
Exchange Act, particularly Sections 15A(b)(6) and 15A(b)(9).

F. Procedures for Use of a Fairness Committee

    New Rule 2290(b)(1) requires that any member issuing a fairness 
opinion must have written procedures for approval of a fairness opinion 
by the member, including: The types of transactions and the 
circumstances in which the member will use a fairness committee to 
approve or issue a fairness opinion, and in those transactions in which 
it uses a fairness committee: (A) The process for selecting personnel 
to be on the fairness committee; (B) the necessary qualifications of 
persons serving on the fairness committee; and (C) the process to 
promote a balanced review by the fairness committee, which shall 
include the review and approval by persons who do not serve on the deal 
team to the transaction.
    In response to the Original Proposal, one commenter suggested 
requiring ``written'' procedures since FINRA refers to having written 
procedures in the rule filing but this is not indicated in the rule 
text itself. FINRA made the recommended change to the rule language.
    In addition, two commenters recommended revising the language of 
paragraph (b)(1)(C) as found in the Original Proposal. The Original 
Proposal required procedures regarding the process to promote a 
balanced review by the fairness committee, which included the review 
and approval by persons who do not serve on or advise the deal team to 
the transaction. Commenters noted that persons who advise the deal team 
often consult with the fairness committee regarding, for instance, 
valuation techniques, and that this advice should not be impaired. 
Commenters also stated that the language in the Original Proposal 
implied that such consultation was not permissible and, therefore, 
suggested deleting the phrase ``or advise.''
    In Amendment No. 4, FINRA stated that it believes that commenters 
may have misunderstood the intent of paragraph (b)(1)(C) in the 
Original Proposal. Nevertheless, in Amendment No. 4, FINRA deleted the 
language ``or advise'' to help alleviate confusion.
    FINRA also noted in Amendment No. 4 that whether a person is 
considered to be part of the deal team requires an analysis of the 
particular facts and circumstances, and will not be determined by 
whether a person is included on all document distributions or 
participated in certain meetings, but rather will depend on the nature 
and substance of his or her contacts and the advice rendered to the 
firm. The Commission finds that this procedural requirement will help 
firms manage potential conflicts of interest and is consistent with the 
Exchange Act, particularly Sections 15A(b)(6) and 15A(b)(9).

G. Procedures Regarding Valuation Analyses

    Paragraph (b)(2) of the Original Proposal would have required 
members to have a process to determine whether the valuation analyses 
used in the fairness opinion are appropriate and the member's 
procedures would have to state the extent to which the appropriateness 
of the use of such valuation analyses is determined by the type of 
company or transaction that is the subject of the fairness opinion. In 
Amendment No. 4, however, FINRA deleted this second requirement because 
it believes that a specific requirement addressing the detail regarding 
the impact of the type of company or transaction on the valuation 
analyses is not necessary. Thus, new Rule 2290(b)(2) only requires 
procedures addressing the process to determine whether the valuation 
analyses used in the fairness opinion are appropriate. The Commission 
finds that this provision is consistent with the Exchange Act, 
particularly Sections 15A(b)(6) and 15A(b)(9).

H. Procedures Regarding Relative Compensation to Officers, Directors, 
and Employees

    Paragraph (b)(3) of the Original Proposal would have required 
members to have a process to evaluate whether the amount and nature of 
the compensation from the transaction underlying the fairness opinion 
benefiting any individual officers, directors or employees, or class of 
such persons, relative to the benefits to shareholders of the company, 
was a factor in reaching a fairness determination. Several commenters 
expressed concern regarding this proposed provision. Commenters argued 
that the proposal implied that members must make a judgment as to the 
appropriateness of compensation to insiders relative to the 
compensation to be paid to shareholders. They noted that members 
issuing fairness opinions do not have the expertise to evaluate 
executive compensation matters and that the appropriateness of 
management compensation is beyond the scope of a fairness opinion and 
that an insider's compensation in general is not a factor in rendering 
a fairness opinion and,

[[Page 59321]]

therefore, this provision does not make sense in terms of how members 
perform a fairness opinion evaluation.
    In Amendment No. 4, FINRA stated that the procedure required by the 
Original Proposal was intended to guard against potential conflicts of 
interest between the member issuing the fairness opinion and those 
insiders who may stand to gain an economic benefit from the 
transaction, and who generally are in a position to make determinations 
about which member will perform the fairness opinion evaluation. In 
response to comments, however, in Amendment No. 4 FINRA deleted the 
procedures in paragraph (b)(3) of the Original Proposal and added the 
disclosure requirements in paragraph (a)(6) to new Rule 2290. The 
Commission finds that this provision is responsive to comments received 
and is consistent with the Exchange Act, particularly Sections 
15A(b)(6) and 15A(b)(9).

IV. Accelerated Approval of Amendment No. 4 and Solicitation of 
Comments

    The Commission finds good cause to approve Amendment No. 4 to the 
proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing of the amendment in the Federal 
Register. The proposed rule change was published in the Federal 
Register on April 11, 2006.\9\ FINRA submitted Amendment No. 4 in 
response to comments received on the proposed rule change. The 
Commission believes that Amendment No. 4 clarifies the obligations of 
FINRA member firms. Amendment No. 4 does not contain major 
modifications that are more restrictive than the scope of the proposed 
rule change as published in the Federal Register. The Commission 
believes that approving Amendment No. 4 will provide greater clarity 
and simplify compliance, thus furthering the public interest and the 
investor protection goals of the Exchange Act. Finally, the Commission 
finds that it is in the public interest to approve the proposed rule 
change as soon as possible to expedite its implementation.
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    \9\ See supra note 3.
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    Accordingly, the Commission believes good cause exists, consistent 
with Sections 15A(b)(6) and 19(b) of the Exchange Act,\10\ to approve 
Amendment No.4 to the proposed rule change on an accelerated basis.
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    \10\ 15 U.S.C. 78o-3(b)(6), and 78s(b).
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    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 4, including whether Amendment No. 4 
is consistent with the Act. Comments may be submitted by any of the 
following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-NASD-2005-080 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-NASD-2005-080. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments, 

all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASD-2005-080 and should be 
submitted on or before November 8, 2007.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\11\ that the proposed rule change (SR-NASD-2005-080), as 
modified by Amendment Nos. 1, 2, 3, and 4, be, and hereby is, 
approved.\12\
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    \11\ 15 U.S.C. 78s(b)(2).
    \12\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-20585 Filed 10-18-07; 8:45 am]

BILLING CODE 8011-01-P
